Greece… the next Lehman??… what to do next?

By: ispeculatornew
Date posted: 02.15.2010 (5:00 am) | Write a Comment  (6 Comments)

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I wrote about it briefly in my financial ramblings on Friday, but it does look like there is a lot of risk of seeing a sovereign nation going down the road of a debt default in the next few months as quite a few countries (including the US) are seeing deficits spiraling out of control. The problem of course is that even one  such case, especially if it happened in a high profile country such as Greece could have effects throughout the world. Read any book that describes the recent financial crisis and you will usually hear that everything started getting out of control when Lehman Brothers went bankrupt. Is Greece going to be the start of a devastating domino effect??

Lehman and Greece both hid the truth for some time

Lehman Brothers said almost until the end that it was fine and there was no real issue or liquidity problem. Of course, Greece has been saying the same all along. For years, it used clever tricks from Investment Banks such as Goldman Sachs to “hide” how bad its financial situation truly was.  As the New York Times puts it:

“In 2001, just after Greece was admitted to Europe’s monetary union, Goldman helped the government quietly borrow billions, people familiar with the transaction said. That deal, hidden from public view because it was treated as a currency trade rather than a loan, helped Athens to meet Europe’s deficit rules while continuing to spend beyond its means.”

Greece has a major ally

Of course, Greek is fortunate to have a major friend as the European Union has a lot riding on its member and that means having nations as powerful as Germany and France have an important stake in Greece. It is far from a given though that European countries will bail out Greece but you could easily make the case that without the EU, sovreign debt default risk (as measured by CDS spreads), Greece would be #1, and it is only at #10:

#10-Greece
#9-Lebanon
#8-Romania
#7-Lithuania
#6-Dubai/United Arab Emirates
#5-Iceland
#4-Latvia
#3-Argentina
#2-Venezuela
#1-Ukraine

Major impacts already

Remember how Lehman Brothers started hearing about market rumors of liquidity issues? This caused most counterparts to start lending to Lehman which in turn created more liquidity issues, and so on. Of course, even with Greece months away from these possible problems, things are already getting much tougher. Foreign institutions and banks have started charging higher rates to Greek banks and cutting off funds. This will of course not help the financial situation of the country. Could all of these talks of a possible default become self-fulfilling?

The Greek government might soon be helpless but for now it is doing its best to get an intervention from the EU: Greek Prime Minister George Papandreou – “There was lack of coordination among the various bodies of the EU — the Commission, the member states, the ECB — and even differences of opinion within these bodies,” he said. “All this has undermined our credibility even within the European Union … all this has not helped our position in the markets.”

Major Impacts in Europe and abroad

And these changes are already making things difficult for Europeans banks. The magazine The Economist puts it best:

“Steep downgrades of the sovereign-debt ratings of countries such as Portugal, Greece and Ireland would probably translate into immediate rating cuts for their banks, as well as higher capital charges on banks’ debt holdings and bigger haircuts when using this debt as collateral.

The consequences of even small changes in a bank’s borrowing costs can be extreme. JPMorgan, an investment bank, reckons that an increase of just 0.2 percentage points in the borrowing costs of British banks such as Lloyds Banking Group and Royal Bank of Scotland would trim their earnings by 8-11% next year”

So imagine if things got much worse and these banks saw capital costs rise by a few percentage points?

How to trade a possible Greek collapse?

Of course, the logical question now would be: “How do I profit from this situation”?

There are many different ways, although it is not as easy for individual investors:

#1-Trade sovereign debt of Greece, Italy, etc (this is much more difficult for individuals)
#2-Short the Euro through an FX trade
#3-ETF plays

As I wrote last week, it is not entirely clear if trading an FX or equity ETF is the best way to do this but here are a few ideas:

Vanguard European ETF (VGK)
CurrencyShares Euro Trust (FXE)

#4-Individual names

The best way to do this would be playing the scenario described by the economist, and trading individual European banks. Some of them such as Royal Bank of Scotland (RBS) are also traded on US markets which makes it an easier trade.

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6 Comments

  1. Comment by Frank — February 15, 2010 @ 9:47 am

    It’s a good parallel with Lehman, but we will see… I can understand that Germany rejects the idea of setting up a special fund to bail out any eurozone countries… If Greece had received help, should Spain, Ireland, Portugal and others also get some help? It’s a difficult and delicate situation. What I can say is that this doesn’t augur well for Euro! Yes, I also agree to short Euro.

  2. Comment by IS — February 25, 2010 @ 7:39 am

    @Frank – No doubt, very difficult time for the PIGS:) I bet countries like the UK, Sweden and Poland are very happy to be out of the Euro at the time being.

  3. Comment by Doctor Stock — February 15, 2010 @ 2:48 pm

    Ahhh… when will responsibility kick in? It’s so frustrating to keep mortgaging the future.

  4. Comment by IS — February 25, 2010 @ 7:40 am

    @Doctor Stock – No doubt about it, I think it’s fascinating that countries keep borrowing with no end in sight…at some point they have to managed better..or else it can bring up scary scenarios.

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